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Microsoft's Windows 7 price gamble - and why it's flawed

Upgrade or die

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But Microsoft's biggest competitor is itself. Windows XP has locked down the traditional laptop and PC market.

Microsoft's big gamble with discounts on laptops, PCs, and netbooks is that Windows 7 Home Premium becomes the default. Then, people will be seduced into upgrading. WAU upgrade discounts will also apply to Windows 7 Professional and Windows 7 Ultimate.

An upgrade from Windows 7 Home Premium to Professional will cost you $89.99. That's compared to $199.99 for Windows Vista Professional customers to upgrade to Windows 7 Professional and $299.99 for a brand-new version of Windows 7 Professional.

Moving from Windows 7 Home Premium to Windows 7 Ultimate will cost $139.99. That's compared to $219.99 for an existing Windows Vista Ultimate customer to upgrade Windows 7 Ultimate and $319.99 for a brand-new copy of Windows 7 Ultimate.

Once you've taken the $79.99, $89.99, and $139.99 WAU incentives and the Family Pack, you'll be locked in. Microsoft hopes to make up the money the next time you upgrade - to something that may or may not be called Windows 8.

Let's say prices for the Windows 8 SKUs stay the same as Windows 7. Then you'll pay the full $119.99, $199.99, $219.99 to upgrade from Windows Home Premium, Professional, and Ultimate to the follow-on Windows 8 versions. That's assuming Microsoft doesn't kill any SKUs along the way.

So, Microsoft is discounting prices to dislodge Apple and build market share, with a long-term view of up-sell. And yet there's a fundamental contraction at the heart of this matrix.

By Ballmer's own admission, lowering price to get what it calls a higher "attach rate" - individual copies of Windows sold with new PCs - has failed.

Ballmer told FAM that Microsoft cut prices in emerging markets this year on the theory that lower price would lead to higher attach rates and total revenue. Microsoft lost both market share and revenue.

"The theory was wrong. It's not that it was untested, but it turns out the theory was wrong, and you will see us address the theory in the Windows 7 time frame," Ballmer said.

There's an important differences between emerging and developed markets. The challenge in developing economies is piracy: Microsoft can cut all it wants, but it still won't be able to beat low-priced or free - the price point for pirated or non-registered copies of Windows.

But in developed economies, the challenge is not so much piracy as Microsoft's existing installation base and Apple. Microsoft will attempt to address the former through discounts. But it will continue to be vexed by the latter.

The Windows Family Pack has already been handicapped by Microsoft because it's a limited time offer that will apply to the US, UK, and 11 other countries.

And on price, an OS X Family Pack still offers more than Microsoft: Apple gives you five licenses, meaning a saving of $519.96. That compares to a saving for $207 if you simply upgrade existing PCs to Windows 7 Home Premium and $447.01 if you install three new copies.

Microsoft is also gambling it can convert netbooks running cheap copies of Windows 7 Starter Edition and Home Basic to Windows 7 Home Premium. That bet is based on Microsoft's large market share on netbooks. But another competitor is showing up in netbooks and it's a competitor Microsoft should not dismiss: Linux.

Linux learns Microsoft lesson

Microsoft COO Turner is hitting retailers over customer return rates on Linux, pointing to poor technical performance and lack of application and peripheral support. But Turner should look to Microsoft's past. The company has been repeatedly dismissed by incumbents in established markets - network and server operating systems, mobile operating systems, email and collaboration - because Windows and Windows applications lacked features or weren't up to the job. Over time, though, Windows improved, and it killed the competition.

Linux will also improve, while the underlying power of netbooks will increase thanks to hardware advances in power and performance. This should mean users are able to do more than just work the web on their machines.

And as far as customer satisfaction and uptake goes, Canonical has launched a set of services starting at $54.99 a year to help people migrate to the fast-growing Ubuntu distro.

With Windows 7, Microsoft is discounting like it's never discounted before, on Turner's theory it can grow market share that can be milked later. The problem is: It's a theory Ballmer said doesn't work in certain markets. The test will be whether Apple is as insignificant as Ballmer says, how far Linux can improve, and whether customers care to upgrade to Windows 8. ®